Investors should tread carefully with telcos — Ovum

11 Oct 2006

Telecoms analyst firm Ovum has urged investment houses to proceed cautiously when it comes to buying into telecoms firms.

Babcock & Brown’s recent acquisition of Eircom for €2.4bn and activist fund Cevian’s purchase of 72 million shares in TeliaSonera indicate a growing interest by investment houses in telecoms firms. However, Ovum points out that while the telecoms sector is an attractive market for telecoms operators, these businesses are not risk-free and nothing is straightforward.

Last year Apax Partners led the purchase of TDC in Denmark and in Spain France Telecom beat off two rival offers from investment groups for Amena.

Mike Cansfield, principal analyst at Ovum, commented: “Telcos are underperforming in terms of what they give back to their shareholders and in terms of their share prices. The opportunity is to buy now while share prices are low, get involved in the management of the company, develop the business and then sell in the future when bigger profits drive values higher.

“But (as ever) there is another side of the coin. Telecoms is a complex high-tech sector that also happens to be undergoing a fundamental transformation. Next-generation networks (NGNs) underpin much of the potential in the sector but these investments are not risk-free.

“Whilst telcos, particularly incumbents, can generate cash — and so pay short-term dividends — they are finding it much harder to grow revenues as the fixed business declines and as mobile growth runs out of steam. Hence low share prices.”

Cansfield continued to say that if you look at how telecom firms are structured, the whole is worth less than the sum of the parts. Traditional telcos are structured in vertical silos like fixed, mobile, ISP or by product line. However, these silos create obstacles to doing business as customers have to talk to each silo separately.

“The opportunity for financial investors is to re-orientate the business to create a greater customer/market focus and in so doing simplify their operation and release value. This is rationalising the distribution side of the business,” Cansfield said.

Another reason why investment firms are interested in telecoms is the ongoing consolidation of telcos’ networks onto one network and cutting out a large swathe of costs. Such actions have been taken by Cable & Wireless when it took over Energis as well as AT&T and the Baby Bells in the US.

“The transformation of the industry through NGNs, convergence of telecoms and IT, and convergent services all enhance this opportunity rather than diminish it. So opportunities exist in telecoms to rationalise the supply-side of the equation too,” said Cansfield.

Cansfield concluded by pointing out that while the fundamentals exist to make telecoms firms attractive and compelling investment opportunities, there is considerable room for risk.

“Without a vertically integrated national telco (ie an incumbent) it is hard to see how this key enabler could be deployed nationally. So whilst the sector is attractive to investment houses, nothing is straightforward.”